Tuesday, October 31, 2006

Who wouldn’t like a 1313 address, or a musty smelling fully equipped dungeon or fourth floor walk up to a widow’s peak full of bats?

Oh well, maybe not but the nation’s home builders sure think Halloween makes for a great marketing opportunity.

Take a look at some of the hoopla that home builders (particularly in Las Vegas) are planning in order to attract potential home buyers:

KB Home offers its Street of Screams, providing families a safe trick-or-treating alternative to the traditional door-to-door candy solicitations. This year, KB will hold the free event in its Chaco Canyon neighborhood of Las Vegas.

Pulte Homes will host its Spooktacular Halloween from 11 a.m. to 3 p.m on Halloween. The first 250 kids will receive Trick or Treat bags, and there will be treats, music and fun for everyone. Palm Hills at Voltaire in Las Vegas.

Del Webb (a subsidiary of Pulte), is hosting additional Halloween events at its new neighborhoods Tuesday from 5 to 8 p.m as well as hosting the Jack-O-Lantern Family Safe Street at The Club at Aliante in North Las Vegas.

Centex Homes will host its Halloween Treat Street in its Giavanna neighborhood in North Las Vegas Tuesday from 5 to 8 p.m. Eleven model homes will be decorated for Halloween and open to trick-or-treaters. Activities will include a haunted house maze in one of the three neighborhood parks that connects the models.

First Homebuiders of Florida (a Hovnanian company) is holding an event titled the “Halloween Haunt” offering “Safe Fun and FREE trick or treating” for kids!

Well at least those home builders are keeping a “stiff upper lip” while thinking of new ways of luring in new buyers.

The Phantom Developer of Collin County: At the height of the '90s land boom, a greedy developer rushed a subdivision into development without checking maps to see that it was an ancient Indian burial site. On the day he was to close the sale on the first lot, the hastily built model home he was sitting in split in two and collapsed because of unstable soil. They say he still haunts the offices of homebuilders across the county, answering the phone when buyers call to complain about delays and telling them, "I'll have someone out to take care of that right away ... right away ... right away ... " before his voice trails off into deathly silence.

Monday, October 30, 2006

Listening to the Bullish banter aired on CNBC on Friday, one would easily be left with the impression that the Great American Consumer is a noble and unstoppable powerhouse, always prepared to take one for the team and spend the country into prosperity no matter what the circumstance.

Desperately grabbing for any number that could possibly be spun positively from the shockingly weak Q3 GDP report, Wall Street bulls zeroed in on the relatively strong “Real Personal Consumption” item which resulted in a 3.1% increase and additionally, the 8.4% increase to the “durable goods” sub-item that would, on the face of it, present a fairly confident posture of consumption of big-ticket, non-perishable products.

Undoubtedly, this 8.4% showing would seem to substantiate the general notion that consumers are unflappable, allowing nothing, not even an impending housing bust and possible recession, to get in the way of their flat-panel TV purchases.

But, how accurate is this analysis? Did the American consumer really increase their spending by 8.4% this last quarter on things like computers, appliances, and motor vehicles?

To find out, let’s delve into the “Durable Goods Report” released by the Commerce Department last Thursday.

First, the following chart (click for larger version) lists the results for items that fall squarely within the bounds of what would generally be considered a consumer product, that is, an item that would normally be purchased by a typical individual for personal use:

As you can see, there are lots of negative results for traditional consumer durables.

So where did the majority of that big 8.4% jump come from if not from electronic products, cars and appliances?

The answer lies in a single line item… New orders of non-defense aircrafts and parts for September.

Yes, you heard right, aircraft. After posting a 12.5% decline in July, and a subsequent 19.9% decline in August, aircraft orders unexpectedly jumped an astonishing 183.2% in September.

So, was this aircraft surge the result of equity laden homeowners using their HELOC winnings in order to finance their amateur piloting hobbies?

Nope, the airline industry apparently booked an unusual number of orders for Boeing jet liners, spending over $14 billion dollars in September alone.

So, as it appears, we may not exactly be the big spenders the traditional media and Wall Street bulls are making us out to be and given that we are about to close out the second straight year where our disposable personal income is not sufficient to pay for our personal outlays thus leaving our personal savings squarely in negative territory, you should ask yourselves, are American consumers really unstoppable?

Friday, October 27, 2006

It’s obvious, at least to this blogger, that the bulls on Wall Street and in the housing industry have been trying desperately to downplay, or even ignore the impact that the bursting national housing bubble would have on the economy.

Their high hopes and expectations are contingent upon their belief that the downturn in housing will be moderate, contained and temporary leaving the general economy free to glide quietly to a “soft landing” as it comes off this historic run-up.

Additionally, they seem so committed to this belief that it appears that no amount of data is sufficient enough to convince them otherwise.

Well, as they say, that was then, this is now…

Today, the US Department of Commerce released its “Report on Gross Domestic Product” for the third quarter of 2006, hopefully, to the genuine dismay of the many bulls eager for a contained and mild impact of the now obvious housing bust.

Easily, the most notable disclosure present in today’s report is the 17.4% decrease in “Residential Fixed Investment”.

The following is the definition of “Residential Fixed Investment” used by the Commerce Department.

Residential Fixed Investment

Investments consisting of purchases of private residential structures as well as residential equipment that is owned by landlords and rented to tenants.

Investment in residential structures consists of new construction of permanent-site single-family and multi-family units, improvements (additions, alterations, and major structural replacements) to housing units, expenditures on manufactured homes, brokers’ commissions on the sale of residential property, and net purchases of used structures from government agencies. Residential structures also include some types of equipment that are built into residential structures, such as heating and air-conditioning equipment.

As you can see, the “residential fixed investment” number is a broad category capturing everything from home construction and rehabilitation to brokers’ commissions and essential home equipment manufacturing.

To put this decline in perspective, this 17.5% decrease shaved 1.12% from the third quarter GDP or roughly equivalent to either the 1.28% GDP reduction coming from all imports of foreign goods and services (i.e. imported goods and services are always subtracted from GDP) or the 1.15% GDP contribution coming from all personal consumption services rendered (think electricity, gas, transportation, medical care, housing, etc.) during the same period.

The following are two different chart views (click for larger versions) showing the percentage change to real residential fixed investment on a quarterly year-over-year basis since Q1 2003.

Clearly, housing is showing a significant decline and its impact on GDP is real and substantial.

Thursday, October 26, 2006

Today, the U.S. Census Department released its monthly “New Residential Home Sales” report for September causing a new round of optimism in the traditional business media.

It was speculated that the reports results, showing a 5.3% increase in new home sales as compared to Augusts revised number, might be a further indication that the recent, widely publicized, perspective suggesting that the nations housing market is setting a bottom may, in fact, be accurate.

This news comes only minutes after former Federal Reserve Chief Alan Greenspan stated that he sees "early signs of stabilization" in the nations housing market with a "flattening" of sales.

This sentiment builds on a statement made earlier this month when Greenspan suggested that for housing “the worst may well be over” citing some perceived stabilization of weekly mortgage applications.

It seems Greensspan’s encouraging outlook set a tone for October, a month in which many in the real estate industry felt confident enough to not only embrace the notion that the housing market had bottomed but to reiterate it at every opportunity.

Hopefully for them though, Greenspan’s viewpoint is more accurate today than it was back in 2004 when he advised consumers to switch over to ARM loans:

"Recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward."

Lenders, being encouraged by the Feds position then, offered many new loan products helping home-owners draw out equity in record numbers as well as home-buyers reach for every available dollar.

Is it possible that the “Maestros” outlook and advice may have finally run its course?

Are there grounds to suggest that Greenspan could possibly be suffering from a serious case of wishful thinking, motivated in part from the obvious loss of credibility that would surly ensue should the nations housing market really revert to the mean?

Remember, not only was it during Greenspan’s tenure that the nations housing market ran wildly out of control, but he left his position without doing much about it other than paying a little lip service to “frothy” markets and “exotic” lending.

Additionally, it seems that Greenspan has been attempting to distance himself from culpability of the housing bubble as his statements suggest during a recent speech:

“I don't think that the (housing) boom came from a 1 per cent Fed funds rate or from the Fed's easing. It came from the collapse of the Berlin Wall,"

In any event, the current edition of the New Home Sales report looks absolutely abysmal.

Among other things, the report showed the greatest drop to new home prices in over 35 years as the median price for a new home declined 9.7% as compared to September of 2005.

Look at the following summary of today’s report:

National

The median price for a new home was down 9.7% as compared to September 2005.

New home sales were down 14.2% as compared to September 2005.

The inventory of new homes for sale increased 14.4% as compared to September 2005.

The number of months supply of the new homes has increased 33.3% as compared to September 2005.

Regional

In the Northeast, new home sales were down 6.6% as compared to September 2005.

In the West, new home sales were down 13.6% as compared to September 2005.

In the South, new home sales were down 7.9% as compared to September 2005.

In the Midwest, new home sales were down 36.6% as compared to September 2005.

In a classic “quote counter-quote” exchange, Bosworth positions this very blog as the “skeptical” response to the National Association of Realtors Chief Economist, David Lereah’s statements regarding yesterdays existing home sale report.

It’s certainly refreshing and even an important milestone to see the traditional media report the hyper-optimistic guidance of one of the real estate industry’s most notable bulls juxtaposed a healthy does of reasonable skepticism and alternative analysis.

Gone are the days of double digit appreciation fueled by speculative buying, loose lending and real estate insider’s penchant for fiction, replaced now by a decline that’s accelerating with every passing day.

As has been typical with this downturn, some in the real estate industry are having difficulty adjusting to the new reality.

“In a normal Illinois housing market we tend to see a slowdown as we enter fall and back-to-school time. This report compares sales to last year’s all-time high for home sales in the month of September. What we’re seeing is a market that is going through an adjustment that is long-anticipated after several record-breaking years. We still have a market with excellent opportunities for buyers and sellers who are informed about market conditions.”

- Robert Zoretich, President of the Illinois Association of Realtors

Take a look at today’s details for Illinois and particularly the Chicago metro market:

Illinois

Median single family home price down 7.8% as compared to September 2005

Median condo price up 2.5% as compared to September 2005

Single family home sales down 20.4% as compared to September 2005

Condo sales down 17.4% as compared to September 2005

Chicago

Median single family home price down 0.4% as compared to September 2005

Today, the National Association of Realtors released its monthly “Existing Home Sales” report for September along with some interesting analysis which paints a picture of market stabilization.

As David Lereah, Chief Economist of the National Association of Realtors puts it:

“Considering that existing-home sales are based on closed transactions, this is a lagging indicator and the worst is behind us as far as a market correction – this is likely the trough for sales, …. When consumers recognize that home sales are stabilizing, we’ll see the buyers who’ve been on the sidelines get back into the market, and sales will be at more normal levels in the wake of the unsustainable boom that we saw last year.”

Additionally, NAR President Thomas M. Stevens added:

“It appears we have passed a cyclical peak in terms of the number of homes on the market,”

In reality though, September not only marked the sixth straight month of sales declines nationally but also the greatest drop to median home prices on record.

Additionally, this month EVERY price and sales indicator was DOWN and EVERY inventory and supply indicator was UP, presenting indisputable evidence that the housing market is declining dramatically and thoroughly across every region of the US.

There should be little doubt now that the housing market is experiencing a significant correction even when looking at a national scope.

The following shows the data form all the NAR reports released today consolidated into one view:

National Statistics (Year-Over-Year as compared to September 2005)

Median price of all existing homes declined by 2.2%

Median price of existing single family homes declined by 2.5%

Median price of existing condos declined by 2.8%

Sales of all existing homes dropped 14.2%

Sales of existing single family homes dropped 13.8%

Sales of existing condos dropped 16.0%

Inventory for single family homes increased 33.9% to 3,200,000

Inventory for condos increased 42.9% to 546,000

The number of months supply for all existing homes increased by 58.7% to 7.3 months.

The number of months supply for all existing single family homes increased by 54.3% to 7.1 months.

The number of months supply for all existing condos increased by a whopping 72.0% to 8.6 months.

Monday, October 23, 2006

Massachusetts is now poised for the greatest yearly sales drop of single family homes in at least the 17 years that sales have been charted by the Massachusetts Association of Realtors.

Wow! Massachusetts is looking so consistently awful it’s hard to imagine anything other than a complete “reversion to the mean” occurring now.

Today, the Massachusetts Association of Realtors reported that for September, single family home sales slipped an astounding 24% as compared to September of 2005.

This brings the current year’s total of single family home sales to only 32,000, well below the 37,740 total for the first 9 months 2005.

As you can see, Massachusetts is headed for roughly 41,800 total single family home sales for 2006 or a decline of 14.1% as compared to the total yearly sales set in 2005. Note, that this estimate includes a fairly optimistic projection of only a 10% sales decline for the months of October through December.

The following chart demonstrates what this drop off would look like in the context of single family home sales since 1990. Click on it for a larger, more readable version.

Again, like last month, we have to keep in mind that we are coming off of an historic run-up in home prices fueled by the frantic speculative madness that had captivated our area for almost ten years.

As in months past, be on the lookout for the inflation adjusted charts produced by BostonBubble.com for an even more accurate "real" view of the current market trend.

Key Statistics for September 2006

Single Family Sales Down 23.9% as compared to September 2005

Single Family Median Price Down 5.3% as compared to September 2005

Condo Sales Down 27.8% as compared to September 2005

Condo Median Price stays flat at 0.0% as compared to September 2005

Inventory of single family homes have risen for 19 consecutive months and now stands at 43,227 units listed on the market through MLS. This represents 12.6 months of supply.

Single Family average “Days on Market” stands at 124 days in August as compared to 85 days for September 2005

Condo average “Days on Market” stands at 114 days in August as compared to 74 days for September 2005

Key Facts

September marks the Sixth (MAR), (ninth per The Warren Group) consecutive month of declining sales.

Boston leads the nation in price reductions with 46.4% of homes listed on the MLS having been reduced.

In this, the first in a four part series covering strategy you can use to best maximize your position as a buyer in a down market, the overall SIPI watching proposition is presented as well as analysis of home sales.

"With many potential buyers on the sidelines right now, we believe there is growing pent-up demand that will come into the market once buyer sentiment improves."

Robert Toll, CEO Toll Brothers Home Builders

Many potential home buyers have been on the sidelines, some ‘kicking the tires,’ but mostly waiting for sellers to compromise on prices and terms,

David Lereah, Chief Economist of the National Association of Realtors

"Many potential buyers now are waiting on the sidelines to see how the market shakes out before proceeding with a home purchase."

David Seiders, Chief Economist of the National Association of Home Builders.

Bernanke admitted it is "very difficult to tell" how far the correction will go as buyers appear to be "sitting on the sidelines."

Ben Bernanke, Federal Reserve Chairman

Whether it’s recited with the tired enthusiasm of a washed up salesman or simply repeated over and over again as a mantra during an episode in fetal position, the statement “the buyers are on the sidelines” and the firm belief that they are just waiting to “jump” back into the market seems to put the minds of some in the real estate industry at ease.

Interesting how the very same real estate insiders love to argue that the housing market is NOT like the stock market when it come to homeowners selling their properties but when predicting the future of buying they present a bullish Jim Cramer-esc “Buy Buy Buy!” scenario.

Certainly, there must be at least some truth to this belief, albeit somewhat less now since federal regulators started prodding the lending industry into tightening up on their “sloppy” standards thus restricting many millions of people who, during the run-up days, would have otherwise had carte blanch over borrowing.

Yet, is it really reasonable to suggest that buyers, all across the nation, are simply biding their time watching and plotting, all the while ready to spring into action at the nearest suggestion that the housing market is back on track?

Though we’ll probably never really know the answer to that one, it does seem sensible, at the very least, to develop a basic strategy for determining when to buy or conversely how long to “hold out” during the downturn.

The main point to come away with is that a buyers market demands an astute buyer.

Remember, the market is weakening, and with a reasonable measure of planning, a shrewd buyer will not only insure themselves against buying a dramatically depreciating asset, they will also maximize their purchasing power while still staying within the bounds of their risk tolerance and personal requirements.

In developing this strategy, let’s consider four basic points of interest every buyer MUST draw on in order to make the best of their position in a buyer’s market; they are sales, inventory, prices and interest rates or to coin a new acronym “SIPI”.

Throughout this series, we will be building up an Excel spreadsheet that will capture the SIPI analysis and when complete, should serve as a powerful tool for performing ongoing analysis in the future.

In this, the first of the four part series, let’s focus exclusively on home sales data.

Interpreting Home Sales

Home sales are a direct measure of buyer activity and a good approximation of buyer confidence and enthusiasm. Simply stated, if home sales are on the rise, buyers are buying in greater numbers, or by contrast, if home sales are slowing, buyers are buying less.

Also, home sales are a leading indicator as you should normally see an increasing number of home sales prior to price increases and decreasing home sales prior to prices falling.

Of course, home sales alone don’t give the full picture as many factors could be influencing home sales numbers and inevitably home prices but suffice it to say that if the number of home sales in any given market is declining, there is much less chance that home prices will be appreciating measurably thus no real impetus to “jump” in to the market in order to avoid being priced out..

They generally publish a monthly report on MLS listed home sales that includes the change, as a percentage, of sales from one month to the next as well as year-over-year changes.

It’s important to note that because of the seasonal nature of home sales, month-to-month comparisons are a little deceptive, its probably more important to focus on year-over-year comparisons as you are comparing the number of homes sold in the same market, at the exact same time of the year, just one year later.

Let’s look at recent data for Massachusetts as an example of home sales analysis:

Notice that in the right hand column there are some pretty significant declines to home sales as a monthly year-over-year comparison of 2006 to 2005. As you can see, Massachusetts is currently experiencing a pretty dramatic falloff in home sales and with it has come over a 10% decline in the real median single home price from the peak set in June 2005.

The key here is that if your state looks any bit like ours does, there should be very little chance of home prices appreciating measurably in the near future so a patient buyer can feel confident that by waiting they are NOT risking having home prices get ahead of their budgets.

Remember, the home sales statistics are generally compiled and published as statewide statistics so you will need to keep a vigilant eye on your target market in order to ensure that it is experiencing similar trends.

In the next part of this series, monthly changes to inventory will be incorporated into the picture further filling out the market analysis.

Thursday, October 19, 2006

There’s nothing like a personal anecdote to cut right to the heart of a matter.

True, they are subjective but still, who can forget all the fantastic tales of open house bidding wars, transient neighbors making windfall profits or flippers trading pre-construction homes and condos like penny stocks?

Stories like those, have now become urban legends, and to a certain extent, have attained a status that will popularly memorialize the mania of the Great Millennium Housing Bubble in our minds forever.

As we all know, the up-cycle of the mania is now long gone, and with its departure goes all the wild, pre-burst stories, now being decisively succeeded by an ever increasing stream of down-side dialog.

In the spirit of symmetry, that is, taking the “bad with the good” even if it is hard to take at times, I have added a new feature to PaperMoney called “Paper Tales” which will provide a daily stream of un-edited “personal interest” stories and quotes ferreted out from various internet sources.

Keep in mind, the purpose of highlighting these stories is not to make light of peoples hardship or poor decisions, but rather, to assemble a log of events, particularly personal events, that have occurred and continue to emerge as we all ride this cycle down.

Hopefully, if not for any other reason, we can all learn a little something about how people behave under unusual circumstances so as to possibly avoid similar situations, if ever an insane housing binge, or any other asset binge for that matter, should ever occur again.

Particularly interesting is that this months report show that virtually every indicator is now recording high double digit year over year declines, with the West region breaking over 40% in declines to housing permits.

Here are the statistics outlined in today’s report:

Housing Permits

Nationally

Single family housing permits down 6.0% from August, down 32.1% as compared to September 2005

Regionally

For the Northeast, single family housing permits down 2% from August, down 31.9% as compared to September 2005.

For the West, single family housing permits down 4.9% from August, down 41.1% as compared to September 2005.

For the Midwest, single family housing permits down 3.4% from August, down 30.5% as compared to September 2005.

For the South, single family housing permits down 7.8% from August, down 27.5% compared to September 2005.

Housing Starts

Nationally

Single family housing starts up 4.3% from August, down 20.3% as compared to September 2005.

Regionally

For the Northeast, single family housing starts down 12.1% from August, down 29.7% as compared to September 2005.

For the West, single family housing starts up 0.9% from August, down 30.8% as compared to September 2005.

For the Midwest, single family housing starts up 3.9% from August, down 33.0% as compared to September 2005.

For the South, single family housing starts up 8.5% from July, down 8.4% as compared to September 2005.

Keep in mind that this particular report does NOT factor in the cancellations that have been widely reported to be occurring in new construction.

As further reports are released, cancellations should show an even greater effect on permitting, starts and completions.

Monday, October 16, 2006

Recently, it had been reported that the Federal Reserve as well as other federal regulatory bodies have been quietly “cracking down” on the sketchy, misleading and even predatory lending practices that had become commonplace during the historic housing boom but now we have proof.

Last week, Brad Morrice, CEO of New Century Financial Corporation (NEW.NYS), a real estate investment trust and the second largest (by market-share) subprime lenders in the United States issued the following statement:

"In light of recent regulatory guidance and the changing interest rate and housing environment, we have reevaluated our programs and practices and developed enhanced policies and techniques to reinforce our goal of providing fair and informed access to credit,"

Today, analysts at Stifel Nicolaus & Company downgrade New Century Financial Corporation to "sell," after citing research they performed suggested that the new underwriting guidelines would likely dramatically reduce loan origination volumes possibly disqualifying 20% - 50% of all loans that would have been issued prior to the guidelines implementation. Their 2007 EPS forecast for New Century Financial was reduced to $4.50 from $6.95.

This is HUGE news to say the least.

Finally, you can now see that there really will be significant changes implemented in the lending industry resulting in dramatically reduced number of loan qualifications.

There’s is not doubt, this is a “turning back the clock” so to speak, on the lending practices that so greatly contributed to creating the national housing bubble in the first place.

This reversal is one of the main reasons you won’t see a “soft landing” bottom or “bounce back” in the housing market even if interest rates remain stable.

Thousands, possibly even millions of borrowers who would have been otherwise qualified for home loans in 2005 are not going to be now and thoes that do qualify will be certainly be qualified for less.

The following are some of the truly unbelievable underwriting changes New Century Financial will adopt:

Tightening underwriting guidelines for its adjustable-rate mortgage programs for at-risk borrowers. This includes using the fully-indexed rate minus 1 percent as the qualifying rate for these borrowers.

Offering existing adjustable-rate mortgage (ARM) and interest-only customers who qualify the option of refinancing into a low fee 30-year or 40-year fixed-rate mortgage.

Implementing plain language disclosures that go beyond legal requirements in explaining terms such as prepayment charges, interest-only features, adjustable-payment features, escrows for insurance and taxes and other key features of a loan.

Enhancing its processes for confirming the income information provided on stated income loans. In addition to the closing certification currently employed, the company will introduce a new front-end confirmation early in the loan process to assist applicants in better understanding the terms of their loan.

So much for home builders learning from their past mistakes; The losses due to write-downs and write-offs due to prior "off balance sheet" transactions such as land options and joint ventures might be the "tip of an iceberg" in deteriorating earnings for the nations home builders.

It’s been mentioned publicly by several well known real estate optimists that home builders have learned valuable lessons from past housing downturns.

Gone were the days of aggressive residential developments and land purchases. This cycle, things would be different. This time, there would be no speculative binge.

That is what was said but what actually occurred during this historic run-up? Were builders actually able to control their urge to over-develop? If not, how badly have the home builders exceeded demand for housing and what impact might that miscalculation have on the future of the housing market?

Probably the single most notable expression of the speculative nature of home builders during this historic run-up is their use of “off balance sheet” transactions such as “land options” and “joint ventures”.

For a more thorough overview of these two types of creative financing tools, read the recent Barrons article "Housing Hangover" but for our purposes let’s use the following definitions:

Land Option – An agreement that a builder makes with a land owner giving the builder the right to buy land for development at a later date. This allows the builder to control parcels of land without having to account for the full cost of the debt that they would have accrued had they actually purchased the lots through traditional means of financing.

Joint Venture – An agreement between a builder and one or more private parties (i.e. private equity funds… hedge funds etc.) in which the builder contributes a 49% (or less) share of the deposit used to finance a large project. In this scenario, the private parties put up the other 51% share of the deposit and the joint venture finances the remaining with traditional debt. Since the builder holds only a minority position (…49% stake) of the deposit, they don’t have to show the cost of financing the debt on their books.

Both of these tools allow a builder to control risk as well as present a more palatable book value in an industry very sensitive to straight “assets minus liabilities” analysis.

Trouble is though, as the downturn continues to take effect, the viability of the projects created by these agreements is starting to become more uncertain. Builders are increasingly walking away from pending projects, requiring them to "write off" the losses in option deposits and venture equity.

The losses from these "write-offs" as well as land "write-downs" (writing off the depreciation of actual owned or optioned land assets) are now starting to show up on the balance sheet of many of the country's largest builders.

The question is are we looking at just the "tip of the iceberg"?

Unfortunaetly, given the nature of these transactions, it's not easy to get an accurate accounting of equity in optioned vs owned lots or joint ventures (listed as interest in unconsolidated entities on a balance sheet) but looking at the 2005 annual reports, the latest quarterly reports and other sources a basic profile can be roughly produced.

Lets look at whats been reported for several of the larger home builders (please feel free to double check and amend my numbers as it was a bit of a puzzle putting these profiles together):Toll Brothers

$238.1 million or equivlent of 9% of the $2.76 billion in 2005 book value in "off balance sheet" transactions.Owned vs. Optioned home sites 2006

44,000 lots owned38,900 lots optioned82,900 lots ratio of 53%/47%

Total Equity in "option" and "joint venture" agreements 2005

$152.5 million joint ventures$ 85.6 million options$238.1 millionFor 9 months ending August 31 2006, Toll Brothers had a total of $37.0 million in "write-downs" to owned-optioned inventory valuation adjustments.

Pulte Homes

$379 million or the equivlent of 7% of the $5.96 billion 2005 book value in "off balance sheet" transactions.

Owned vs. Optioned home sites 2005

157,780 lots owned185,220 lots optioned343,000 lots ratio of 46%/54%

Total Equity in "option" and "joint venture" agreements 2005

$302 million joint ventures$ 77 million options$379 million

For 6 months ending June 30 2006, Pulte had a total of $62.0 million "write-downs" to owned-optioned inventory valuation adjustments.

Lennar

$2.75 billion or the equivlent of 47.6% of the $5.25 billion 2005 book value in "off balance sheet" transactions.

Owned vs. Optioned home sites 2005

98,000 lots owned205,000 lots optioned303,000 lots ratio of 33%/67%

$1.45 billion joint ventures$1.30 billion options$2.75 billion

For 9 months ending August 31 2006, Lennar had a total of $93.6 million in losses attributed to off balance sheet transactions.

$41.1 million "write-offs" of "option deposits"$35.8 million "write-downs" to owned inventory valuation adjustments$16.7 million "write-downs" to equity valuation of "joint ventures"

Probably the most striking aspect of the above profiles are the sheer numbers of lots that the nations builders control. Toll Brothers walked away from roughly 10,000 lots in just the last quarter leaving the lots owners in the likely position of reselling them through other means. Given the current climate, clearly, this must equate to a rapid depreciation in value of many thousands of buildable lots across the country. Only time will tell what the total impact of these canceled deals will have but its probably safe to conclude that they will likely exacerbate the already poor inventory conditions.

"In the current environment, we have reduced our land position. In total, we now own or control approximately 82,900 lots, compared to approximately 91,200 at second-quarter-end. We continue to reevaluate the lots in our approval pipeline and to renegotiate or drop those options that we believe are no longer attractive."

- Bob Toll, CEO Toll Brothers August 22, 2006

"The U.S. housing market has continued to deteriorate, trailing down further and faster than anticipated. Under these difficult conditions, we remain focused on our strategy of carefully managing inventory, reducing construction costs and overhead, methodically tapering back production and emphasizing cash generation. We have limited our land purchases and reduced standing inventory through strategic asset management."

Thursday, October 12, 2006

Today the Federal Reserve Board released its almost monthly “Beige Book” report for October, which presents an anecdotal summary of economic conditions in each of the twelve Federal Reserve Bank districts.

Across New England, the pace of residential sales continues to be slow compared to 2005. In Massachusetts, the average number of days on the market has increased by a full month since last year, to around 110 days. Contacts attribute slower sales to less urgent buyers focused on getting the highest value for their money. Slow sales combined with increased listings have led to inventory build-up in most New England markets. In Massachusetts, single family inventory has increased 16 percent and condominium inventory has increased 28 percent year-on-year, leading to around 10 months of supply currently in the market.

Contacts indicate that as sellers have become more attuned to supply conditions in recent months, they have become more willing to reduce prices. Correspondingly, many New England markets feature declining prices. The median price of single-family homes sold in Massachusetts in August was about 6 percent below its August 2005 level; the corresponding decline for condominiums was 3 percent.

Contacts expect that the pace of sales will remain slow in the near term and that markets will continue to show prices below year-earlier levels.

The region's housing market has shown mixed results since the last report, with further weakening noted in northern New Jersey and upstate New York, but signs of underlying strength reported in New York City. New Jersey homebuilders report that the housing market has continued to slacken since the last report: both buyer traffic and sales activity have declined substantially, the inventory of homes on the market has risen substantially, and prices have continued to slip. One New Jersey contact also notes pronounced weakening in the sub-contracting business, attributing much of the recent weakening in home remodeling to reduced home equity. Similarly, real estate firms in western New York State report that both sales and prices were down moderately in August, compared with a year earlier.

Bankers in the District expect business and consumer lending to increase in the months ahead, but not strongly. They also expect gains in credit card lending. However, they anticipate a further decline in the demand for residential mortgages. Some bankers also said they expect an increase in mortgage delinquencies as payments of principal start to become due on non-amortizing mortgages and as rates rise on adjustable-rate mortgages.

Residential contractors reported new home sales are down or flat when compared to earlier this year. Year-over-year sales declines of 10 percent or more are common with a few contacts saying the market is down by as much as 60 percent. Several contractors reported that they no longer have any backlog. Most home builders expect sales to remain soft for the remainder of the year with 2006 totals to be below those in 2005. Many contacts said that material costs have stabilized over the past couple months with a few noting a drop in the price of lumber. About half the homebuilders contacted reported reducing their labor force through direct layoffs or by not replacing workers that leave.

Residential real estate agents across the District noted generally slower home sales in September. A Washington, D.C., agent described that area's housing market as "horrible," adding that sales volume was down 25 percent from a year earlier. Additionally, he reported that home inventories had risen sharply and that some sellers were trimming asking prices. In Virginia Beach, Va., an agent also noted weaker home sales, saying that buyers were being more selective. Many District agents told us that inventories in their housing markets continued to rise and that buyer traffic had slowed. Modest decreases in home prices were noted by contacts in many areas, and an agent in Richmond, Va., told us that sellers were offering more incentives to prospective buyers.

Slowing loan demand, aggressive competition for deposits, and strong credit quality, characterized reports from the District's banking sector in September. Weaker real estate loan demand was noted in most parts of the District, while reports on commercial and industrial lending were softer than in the last report. Higher foreclosure rates were reported in parts of the region as increased interest rates affected borrowers with adjustable rate mortgages. However, bank credit quality indicators remained strong.

Residential construction and real estate activity declined again in most areas. Homebuilders observed sluggish demand in all market segments, and a Chicago-area builder said high-end properties have been taking noticeably longer to sell.

Builders in southeast Michigan reported a number of project cancellations. New home prices were steady to down, and several builders were adding free upgrades to help sell homes. A contact in Michigan noted that list prices of existing homes were being reduced as well.

August year-to-date home sales declined about 2 percent in both St. Louis and Little Rock. Residential construction remained weak throughout the District. August year-to-date single-family housing permits were down in nearly every metro area. Compared with the same period last year, permits fell 34 percent in Louisville, 21 percent in greater St. Louis, 11 percent in Memphis, and 8 percent in Little Rock.

Residential real estate continued to slide. August home sales in Minneapolis-St. Paul were down 27 percent from 2005, with pending sales down 23 percent. Sales were down 10 percent from last year in the Upper Peninsula of Michigan; the market for recreational land is the only strong segment there.

The residential real estate market continued to soften while commercial real estate activity expanded. Contacts indicated that home starts, traffic of potential buyers, and home prices were down relative to a year ago. Inventories of existing homes rose and contacts reported that the time-on-market for homes lengthened, despite the increased use of concessions to attract buyers. Home sales were soft in most segments of the housing market, with particular weakness in low to moderately priced housing markets.

The housing market continues to soften but remains quite strong. Sales are particularly strong in Houston, Austin and El Paso. Dallas real estate agents say the "buying fervor" is a little slower, but relocations and healthy job growth are still boosting activity. New home inventories have inched up, despite strong demand in some markets. Building is expected to slow from the rapid pace of growth seen earlier this year. While the market remains strong, contacts have become "more nervous and anxious" in their outlook, especially given recent reports of a decline in housing sales and prices at the national level.

Demand for residential real estate fell further in most areas, while activity in commercial real estate markets continued to expand but at a slower pace than previously in some areas. The pace of home sales, construction, and price appreciation slowed further in most parts of the District, and contacts in some areas noted that developers have been offering price concessions and other incentives to entice buyers.

Wednesday, October 11, 2006

There has been a long standing belief (or at least a widely publicized talking point) by some economic bulls, particularly those in the real estate industry, that there can be no national housing bubble because there is no national housing market.

Trailing that supposition is usually the minor disclaimer that of course there are many regional markets that could very well be experiencing bubble like conditions.

Granted, the nations housing market is clearly an aggregate of several hundred regional markets many of which historically have never even exhibited cyclic price movements.

Yet, something about the argument seems to fall flat.

Could it be the way the “raging” real estate bulls such as David Lereah or Barry Habib use this simple line of reasoning all the while employing a host of national statistics to support their notion that the real estate market is “stabilizing” and will inevitably experience a “soft landing”?

How can you have it both ways?

If you discount the possibility of a national housing bubble based on the mere fact that housing is regional then how can you support the idea of price stability in the housing market by citing national statistics.

Let’s make it even simpler. If there is NO national housing market, than what good is looking at the national median home price statistic? That indicator has very often been cited by real estate bulls as an overall measure of the stability of the housing market.

How about pending home sales, housing starts or the myriad of other national real estate statistics?

The point is, if you’re not willing to accept the idea of the national market exhibiting a trend in the negative direction than the same has to apply for trends in the positive direction as well.

The key here lies in trying to establish the extent to which the country, in terms of its regional markets, is actually experiencing a housing bubble and to determine how many people and homes in those areas may be effected.

In an effort to gain some perspective lets look at the following sheet which lists some simple metrics for the current 16 top declining housing markets in the US.

Each listed region shows a double-digit decline in year over year, Q2 home sales.

The population living in these regions total 114.8 million or roughly 38.7% of the total US population.

The number of single family units in these regions total 27.5 million or roughly 36% of all single family homes in the US.

Keep in mind that the areas listed were only the “Top 16” out of an total of 28 states and the District of Columbia that showed declining sales in Q2 2006.

So as you can see, no matter how you look at it, nationally or regionally, the current housing slowdown is effecting a significant percentage of the US by population and by housing stock. In fact, so much so that we may soon see one or more months of declines to the national median home price, an event that has not happened since the Great Depression.

Tuesday, October 10, 2006

For those of you that may not have seen the latest news, former Federal Reserve Chairman, Alan Greenspan, has indicated that he believes the worst may be over for the housing downturn.

“I suspect that we are coming to the end of this downtrend, as applications for new mortgages, the most important series, have flattened out,”

“There is a good chance of coming out of this in good shape, but average housing prices are likely to be down this year relative to 2005. I don't know, but I think the worst of this may well be over”

Not surprisingly, “analysts” across Wall Street have picked up on his comments today and issued a slew of “Buy” ratings for many of the largest home builders.

The “air” of CNBC is filled with giddy talk of reaching the “bottom”!

Rather than go on with a lengthy discussion, Id like to remind you what Greenspan stated last May while attending a Bond Markets Association dinner:

"This has been quite an extraordinary boom…. home sales are off, applications are off, everything is going in the same direction. The boom is over, and you can say that with a fairly strong degree of confidence."

As well as what Bernanke said just last week:

"[The US housing market is undergoing] a substantial correction… Weaker housing likely will shave about one percentage point from gross domestic product growth in the second half of 2006,"

So, who’s right? Greenspan back in May and Bernanke now or the current Greenspan?

A few months ago I wrote to you about the changing market conditions in our industry and our concerns about how long the downturn in homebuilding may last. Since that time, the market has slowed further still, representing one of the steepest declines in new home sales in our memory. Most of our markets have been affected, some severely. At this point, we are preparing for a long period of slower sales, at least through 2007 and perhaps beyond.

What does this mean for you and for our Company? These new market conditions have affected us in many ways and will continue to affect us in the months ahead. In the area of land acquisition we have been re-evaluating our current land positions and the contracts for new land in the light of these new conditions. Many of those contracts no longer make good financial sense when you factor in lower prices and a slower sales pace. In cases where we have been unable to renegotiate these contracts with more favorable terms, we are canceling them, at times forfeiting our deposit monies. It is important to state that in all cases where we have canceled contracts, we have acted legally and with integrity, adhering to the very specific terms of those contracts and exercising previously agreed-upon terms of cancellation. We continue to have an ample supply of land for our future growth, but we need to be sure that the communities we develop can be profitable.

Our local and national Purchasing teams have been pro-actively working with our service providers, material suppliers and trade partners to find ways to reduce our costs, through better pricing, defect reduction and product specification changes. We have been successful in many of our Business Units in finding significant cost reductions through cooperation with our business partners. We continue to work on ways to reduce costs.

We have also had to make adjustments to our pricing in order to make sales, either through added features, free options, waived premiums or outright base price reductions. In a market where our competitors are making dramatic pricing concessions, we must make similar adjustments in order to remain competitive. Obviously, this has a significant impact on our profits on those homes that we sell at a discount.

The most difficult adjustment we have had to make to the changing market is in the area of staffing. In many locations, including corporate headquarters, we have been forced to face the fact that we no longer have enough work for all of our Associates. We were hoping that normal attrition and a reduction in new hires would prevent us from needing to take further action. Those steps helped, but did not solve the problem of having too little work for our entire team. As a result, we have had to make staff reductions.

We consider this action to be a last resort, but business realities demand action in order for our Company to remain healthy and to maximize our performance in a difficult market environment. We know that this causes pain not only for the families of displaced Associates, but for our remaining Associates as well. In all cases, we are treating our displaced Associates fairly and with dignity. We are providing severance and outplacement services where they are available. There may need to be more adjustments if the market continues to slow. We will make those decisions with great care and sensitivity and we will try to keep you well informed of any changes.

What can you do to help us continue to prosper during these challenging times? First and foremost, you can continue to focus on delighting our customers. Companies with “raving fans” prosper during good times and bad. We have made great improvements in this area, but we have much room for continued improvement. Regardless of the market conditions, we will continue to invest resources and support to further our goal of being an industry leader in customer satisfaction. Don’t let a soft market deter you from doing everything you can to create a great customer experience.

Second, you can help us to eliminate waste and rework, which costs our Company literally millions of dollars each year, by focusing on process improvement and defect and error reduction. Help us to eliminate unnecessary costs by spending our money wisely. Here at Corporate headquarters, we launched a “great idea” program where Associates submitted nearly 200 ideas for cost savings, generating the potential for huge savings. In just one example, our new contract for overnight shipping services in switching to DHL will save us up to a million dollars annually! There are many such opportunities all around our Company and we need you to help us identify them.

Finally, you can continue to do the great work you do for our Company every day. Challenging times allow the best and the brightest to truly shine. We have a lot of work to do and thousands of homes to sell, build, close and service. We all need to keep our heads down and get the job done, every day.

As always, and for good reason, I remain highly optimistic about the future. Our Company is very strong financially. With $1.5 billion in our credit facility, a strong cash position and $2 billion in shareholder equity, we have the capital resources needed to weather the storm and to position ourselves to take full advantage of the opportunities that markets like these always present. The market will gain strength eventually, and we will be poised and ready to take full advantage of it. We will emerge from this market stronger and better.

Thanks to each and every one of you for all you do to help us become THE BEST homebuilder in the nation.

For those of us who concern ourselves with every little twist and turn of the ever-changing state US housing market, it can be easy to loose perspective and conclude that everyone else interprets the data similarly.

In fact, though, nothing could be farther that the truth. At every turn there seems to be some willing to ignore what would seem like fairly substantial evidence that things are awry, in favor of some “reinterpretation” or otherwise “new era” view of things.

In March of this year, a husband and wife team of Gary and Margaret Hwang Smith, two professors of economics from Pomona College presented a paper at the Brookings institute entitled “Bubble, Bubble Where’s the Housing Bubble”. The paper, subsequently being widely read and reported on after landing on the front page of the New York Times, presented a new analysis of housing that would seem to all but eliminate the possibility that housing bubbles were occurring, even in some of the most active and “frothy” markets.

"Most of the country is certainly not in a bubble if you define a bubble as prices far above fundamentals," said Gary Smith, who is the Fletcher Jones Professor of Economics at Pomona College. "The average person in the U.S. is still better off buying than renting."

More recently, two Congressional economists made similar arguments in the spring 2006 edition of widely read quarterly journal.

In the article entitled “A Collapsing Housing Bubble?”, Ike Brannon and Suzanne Stewart, who are apparently members of the staff of Senator Orrin Hatch, skillfully present several arguments that seem to dispel the possibility of a housing bubble.

Particularly notable was the presentation of the ratio of “owners equivalent rent” to two different home prices indexes.

Arguing that the Office of Federal Housing Enterprise Oversight (OFHEO) Home Price Index over-represents the impact that home improvements have on the accuracy of such a ratio, the authors offer an alternative home price index to base the analysis.

Claiming that the Census Bureaus “Constant Quality Index”, an index that attempt to track home prices of “equivalent quality” homes over time, would be a better fit for such analysis, the authors produce a chart which would have one easily concluding that there is no significant discrepancy between rents and home values thus bubble fears are overdone.

Trouble is, they forgot to mention that the “Constant Quality Index” has many significant flaws in its formulation not the least of which is that it tracks a mere 14000 homes compared to the 32 million homes accounted for by the significantly more widely accepted OFHEO House Price Index.

The paper goes no to describe two significant benefits of the “interest only loan” finally concluding with the following prophetic quote:

“With no specter of inflation in our future and a world of relatively low returns, investing more in a house makes perfect sense. A stagnant stock market does not send off the siren song to investors that it did a decade ago. Who is to say that in such an environment a family spending another $100,000 on a nicer house is not making a wise decision?”

Now, with housing sales in 28 states and the District of Columbia in full decline and prices starting to follow suit, one wonders how sensible it was to formulate and widely distribute such imaginative papers.

Each individual metro report contains sections dedicated to local price activity, affordability, home sales, mortgages trends and fundamentals as well as a final “Risk Factor” summarization and “Pricing Scenarios” predictions.

In typical fashion, NAR tries in earnest to present the data in its most positive light spinning some significant indicators of the market instability with fine tuned hocus pocus.

In the section dedicated to affordability, they suggest that home prices, having significantly outpaced incomes in recent years, results in a price-to-income ratio that is often cited as an implication of a housing bubble. Each report then goes on to suggest that since mortgage interest rates have been at historical lows, a more relevant ratio to analyze in determining the existence of a bubble would be the ratio of “median mortgage servicing” cost to “median income”.

Certainly, this classic “it’s not how much it costs that matters, its how much you can afford” logic makes things look significantly better as you ignore the fact that the overall debt burden has just doubled (or more) and instead focus on the cost of just the loan payment relative to the current income. Not to mention that many markets show absurdly high percentages of ARM loans so the servicing costs are likely to be increasing soon.

Additionally, the “Pricing Scenarios” section attempts to mask the very real scenario whereby just a 5% drop in home prices puts the majority of the metro areas 2005 home buyers into negative equity. NAR terms this grim scenario “equity loss”.

Each report then closes with a five point sales pitch on the tax benefits of owning a home, why homes are not like other equities (i.e. cant trade like stocks so doesn’t show the same volatility) and the fact that national median prices have not declined since the Great Depression.

Arguably, the most interesting statistic disclosed by the reports are simply the sheer number of metros exhibiting the obvious signs of the asset run-up as wells as the now prominent slowing to decline.

Second best might be the unbelievable percentage share of ARM loans that have been used to finance homes. Most metros will show 20-30% with some, such as Las Vegas, showing a whopping 58% of all loans being ARMs.

Monday, October 02, 2006

The National Association of Realtors developed the “Pending Home Sales” index as a leading indicator based on a random sampling of roughly 20% of the month’s transactions for exiting home sales and indexed to the average level of contract activity set during 2001.

In an effort to use any “positive” numbers as a means of reassuring hesitant buyers, David Lereah, NAR’s Chief Economist states in a release titled “Pending Home Sales Index Shows Market Stabilizing”, “Our sense is that home sales may have reached a low in August – the Pending Home Sales Index shows home sales should be fairly stable over the next two months, although a minor decline is possible”

As usual, looking more closely at the results one might draw a less optimistic conclusion:

-Nationally the index was down 14.1% as compared to August 2005

-The Northeast region was down 12.4% as compared to August 2005.

Additionally, August marks the third consecutive month that this region has registered activity BELOW the average activity recorded in 2001, the first year Pending Home Sales were tracked.

-The West region was down 16.9% as compared to August 2005.

-The Midwest region was down a whopping 20.4% as compared to August 2005.

Additionally, August marks the second consecutive month that this region has registered activity BELOW the average activity recorded in 2001, the first year Pending Home Sales were tracked.

-The South region was down 9.4% as compared to August 2005.

So it appears that, year over year, contract activity is dropping rather sharply with the Midwest and the West regions now showing significant declines.

So much for pending contracts pointing to further “market stabilization”.